The Myth About ELSS Fund Lock-in

Many years ago, I found, in an exchange of comments in a blog, a curious statement: ELSS funds have a lock-in period (of 3 years). Hence, the fund manager can operate without redemption pressure, resulting in better returns. No evidence was provided to prove or disprove this statement and I thought no further about it.

A few days ago* , a video was posted in FB group, Asan Ideas of Wealth.

(*) This was in Jan 2015. I have updated this post with current data.

It was a clip from a Tamil TV program on finance. A financial adviser before suggesting funds to a caller, made the same statement as above (at ~ 8 mins):

‘In an ELSS fund, the fund manager can take ‘long-term’ calls without fear of redemption’. He went on to state (in English), because of the lock-in, “All the tax-saver funds have given the best of returns”.

Therefore, he goes on to advise that a ELSS fund should be part of a folio, even if 80C benefits are not required!

That is too strong a statement and too weird an advice for me to leave alone. Besides, I have found such statements made in other places on the web from time to time.

First some history of ELSS funds, courtesy of IFA Deepak Khemani:

Under the provisions of Section 80CCB, investment in units of a notified equity linked savings scheme was eligible for deduction from the total income up to an amount of Rs.10,000 in a previous year. This deduction was allowable for investments made during the period from 1st April 1990 to 31st March 1992.

The first of these schemes was launched in 1991 by UTI followed by other Pvt Sector MFs.

This was then merged into Section 88 which still had a sub-limit of 10000 for ELSS.

Section 80C replaced the existing Section 88 with more or less the same investment mix available in Section 88. The new section 80C has become effective w.e.f. 1st April, 2005. Even the section 80CCC on pension scheme contributions was merged with the above 80C.

Therefore, using the SIP comparison tool at thefundoo, I have compiled the XIRR of all ELSS funds from Jan. 31st 2006 (could include a few more funds, with this date) and (almost) all Large-cap, Large-mid cap, Mid-small cap funds using the date of inception listed at VR online.

Here is the distribution of returns.

Here are the actual XIRR values.

ELSS funds

Large cap, Large-mid cap andMid-small cap funds

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Update Jan 2016

I have now compared ELSS (which are typically diversified with a large cap tilt with Equity multi-cap and equity-oriented balanced funds)

There is no evidence from the distribution (incl the new graph) and actual XIRR returns for the period considered that ELSS funds are better than other equity fund categories. The dispersion in returns in both ELSS and non-ELSS funds is equally large. There is also no evidence that spread in returns for ELSS funds is lower than other categories (even though the number of ELSS funds studied is much smaller!)

Thankfully, most of the funds at the lower end are index funds or belong to dud fund houses. Most of the active funds (ELSS or not) have done well. This again proves what I wrote earlier: Fund Selection is NOT important

Mutual Fund investing is hardly rocket science, however investors attitude towards long-term investing apparently is rocket science! Those who can recognise common sense when they see it, will realize that investor discipline to keep investing and stay invested is far, far, far more important than fund selection. So stop asking others for what funds they hold! Also, please do not use this data to extrapolate that mid-small cap funds always do better than other categories. The mid-small cap category is not old enough for such statements.

Back to the current issue:

The IFA in the above video claimed that inflow to ELSS funds are higher than outflows due to the lock-in and this allows the fund manager to take ‘long-term calls’. While this is likely to be true, it has no impact on performance or rather, it does not make ELSS funds superior.

For the first 3Y since inception, the ELSS fund is a closed-ended fund. There is no outflow. As time passes, investors can take out their money and outflows gradually increase. Either the outflows are not small enough, for ‘superior performance’ or they simply do not matter.

So the kind of generalizations made in the program and in other places are absurd and baseless.

Human beings thrive on extrapolation. They see a couple of instances (be it human behaviour, stock of fund movement or what not) and without any second thought extrapolate it as the norm. They then go on to advise this finding as the ‘best’ option to others!

Moral of the story: Invest in ELSS funds for the tax break that they offer (as long as they offer it!) but do not expect superior performance. Understand the investment strategy of the ELSS fund and ensure there is no other fund with a similar strategy in your folio. Not all ELSS funds are the ‘same’ in terms of where they invest.

A diversified folio is the ticket to superior risk-adjusted performance. Not lock-in.

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M. Pattabiraman(PhD) is the founder, managing editor and primary author of freefincal. He is an associate professor at the Indian Institute of Technology, Madras. since Aug 2006. Connect with him via Twitter or Linkedin Pattabiraman has co-authored two print-books, You can be rich too with goal-based investing (CNBC TV18) and Gamechanger and seven other free e-books on various topics of money management. He is a patron and co-founder of “Fee-only India” an organisation to promote unbiased, commission-free investment advice. He conducts free money management sessions for corporates and associations on the basis of money management. Previous engagements include World Bank, RBI, BHEL, Asian Paints, Cognizant, Madras Atomic Power Station, Honeywell, Tamil Nadu Investors Association.For speaking engagements write to pattu [at] freefincal [dot] com

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Keen reader of your blog and admire you for your efforts .In case of Elss 95% are large cap oriented. Exception is Reliance Tax saver so it is comparing apples to oranges.Second starting from a particular point is itself flawed ,the way to compare is by taking rolling returns .Third tax saving is some sort of compulsion so every one has to put money in tax saver .Fourth for some people these lock in itself is reason for wealth creation so it cannot be generalised.Will be interesting to see a data how many people have created wealth in elss and how many in regular open ended funds.

Keen reader of your blog and admire you for your efforts .In case of Elss 95% are large cap oriented. Exception is Reliance Tax saver so it is comparing apples to oranges.Second starting from a particular point is itself flawed ,the way to compare is by taking rolling returns .Third tax saving is some sort of compulsion so every one has to put money in tax saver .Fourth for some people these lock in itself is reason for wealth creation so it cannot be generalised.Will be interesting to see a data how many people have created wealth in elss and how many in regular open ended funds.

I am not doing the apples to orange comparison. The distributors are. The point chosen is when they became pare of 80C If I have to use rolling returns, I will need to do it for all funds. which is not possible. I will surprised if a 3Y lock-in creates wealth. I never said dont use ELSS for tax-saving. The point is that it not correct to assume that the lock-in gives better returns. There is no proof of that.

I am not doing the apples to orange comparison. The distributors are. The point chosen is when they became pare of 80C If I have to use rolling returns, I will need to do it for all funds. which is not possible. I will surprised if a 3Y lock-in creates wealth. I never said dont use ELSS for tax-saving. The point is that it not correct to assume that the lock-in gives better returns. There is no proof of that.

Excellent analysis as always sir. A point I noted may be of interest. I used to have sip in QLTEF and then I noticed QTSF gave better returns as well as tax benefits, so I shifted SIPs to QTSF. I guess the reasons for better performance in this instance are:- 1. >80% mandatory equity in ELSS makes it better in bull runs if a fund with a substantially similar portfolio has lower equity share. 2. At that time QLTEF was having 30% in cash and market was booming.

well said about under performance of QLTE! one legend expert said;people are loosing more money in fear of correction than actual correction. Quantum AMC is expecting correction since long , very first in indian mutual fund industry! thank God that the regulator kept >65% mandatory equity in equity mfs, otherwise they might have come in 100% debt! thank you for stating >80% mandatory equity in ELSS. I was guessing same as any equity fund.

ELSS funds must be taken as tax savers and reviewed after the lock in period is over, your analysis makes this clear. I would also like to add that investors must remember that in case of ELSS SIPs, the 3 year lockin applies to each SIP instalment and secondly, that even units that are received under Dividend Reinvestment have a 3 year lock in. This lockin for Dividend Reinvestment units is applicable, even if you have redeemed the original ELSS investment. So it is better to use a Growth or Dividend Payout option.

Sir, thank you for busting this myth about ELSS funds being better performers due to the lock-in effect, clearly the data shows that this isn’t the case. Another takeaway I get is that ELSS should be viewed for tax saving purposes only.

I do have one question, which might be outside the scope of this article – if an investor falls in the 30% tax bracket and invests in ELSS, should he include the tax savings as part of the returns calculations? Although this sounds intuitive, I don’t know if this is a right approach.

https://www.valueresearchonline.com/default.asp?r=r In the above link, under fund category returns, Tax savings funds have more returns than large cap and large & mid cap funds: for 3 and 5 years. Why the data you are showing is different and showing different conclusion. Please clarify

Frankly, keeping track of Dividend Reinvested units is a problem, they are typically a small component of your investment. Even if dividend yield is say 7-8%, I do not know whether many investors would like to keep this small part locked for 3 years. If one had used the Growth option, one can atleast sell these units and reinvest the proceeds elsewhere. I have experienced this myself.

Only way investors making more from investments in ELSS can be because of longer term, they are forced to stay put for 3 years, if it is a SIP then it will be 3 years for each SIP But again 3 years is not a large enough period for equities unless of course the person is redeeming and investing the same money again for tax saving purpose

Respected Pattu Sir, I have a different view on this. I want to drive home a point that theoretically tax saving funds are in no way inferior than other non tax saving funds. I feel that if one selects a fund properly a tax saving fund can give better return than a non tax saving fund and vice versa also. You have demonstrated with figures that non tax saving funds have given better returns. I agree but we need to investigate further. What could be the main reason behind this ? I think that at least lock in period can not hinder the performance of a fund if not improve !

Hi, I think you are right this should be added. This platform also good in their respective plans.We just can’t ignore them.So please Pattu sir, if you can tell us what is the reasons you haven’t added this platform in your list.

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